Ten predictions for China's economy in 2015(3)

7. The central government will increase leverage to sustain the economy in the face of credit risks

The whole Chinese society's debt ratio is about 210 percent. The debt risk is under control. Government and households have a relatively low debt ratio, so there is still room for leverage. In 2015 the central government will shoulder more responsibilities by keeping up with targeted easing to increase leverage of projects aimed at maintaining steady economic growth, which will win more time and room for the country's on-going reform.

With the fading of external demand and the property dividend, it is a must to increase leverage in order to sustain economic growth. It is highly possible that the debt ratio will continue to expand in 2015, so uncertainty lies in whether some of the projects could increase their efficiency of leverage. It means paying attention to state enterprises to see if the reform will increase the competitive power of the state enterprises, and paying attention to local non-transparent debt sources to see if they will be effectively restrained. Under the control of a borrowing limitation, local governments can be allowed to issue bonds and the income and expenses of the general debts are allowed to be managed in the public budget realm. The government financing function should be stripped from the financing vehicle. The development direction for local debt will be to channel social funds to the construction of infrastructure.

Credit risks will probably go to the verge. Most debt stock will be kept to avoid systemic financial risks. Sporadic risks may occur: first, the economic downturn will make financial institutions hold back their risk appetite for private sector and pay attention to the credit risk of private sector. Second, the central government will curtail local budgets and there will be a commercialization of city construction investment bonds. We should be cautious of the credit risks caused by some city bonds which are outside the budget management or the bonds from the financially weak local governments.

8. Monetary policy will continue to focus on targeted easing , and there may be targeted RRR cuts.

The monetary policy will stick to targeted easing in 2015. If the pressure of U.S. dollar liquidity backflow mounts up, there will be possibilities of targeted RRR cuts. But as the cuts are mainly aimed at hedging in the gap when funds outstanding for foreign exchange shrink, it is not total volume easing. Monetary policy in 2015 is expected to keep the aggregate at a stable level and optimize the structure of the economy. An overall rate cut is unlikely.

First, if the U.S. dollar is going strong, the need to continue keeping the required reserve ratio high is not enough. As the U.S. Federal Reserve will raise interest rates, a strong U.S. dollar will be established. A strong dollar will weaken the willingness of private sector to carry out foreign exchange settlements. In the past, the high required reserve ratio was to counteract the excess liquidity of funds outstanding for foreign exchange. But when the funds stop being the main channel for putting China's monetary base into circulation, it makes no sense to maintain a high level for the required reserve ratio.

Second, targeted easing is still needed. The pressure of an economic downturn is still there and the financial income will grow weakly. At the same time, the real estate market is on a downturn and income from land will not be sufficient. Targeted easing will take advantage of the central government's low leverage ratio, so that land financing can grow steadily through policy banks.

Finally, if the Federal Reserve raises interest rates, China's central bank will not have room for a rate cut. As the U.S. dollar is very likely to be strong, the Fed's rate raise will not give China much leeway to cut its rates as China will fear capital outflows.

9. The stock market will face a prolonged battle, and the structural market continue to perform, and overall bull market will unlikely appear.

In the next year, under the "new normal" of economic structure adjustment, reform and transformation, the structural bull market will continue. But on the other hand, as the excess capacity has not been offset, the debt risks are still high, and as there is lack of an external incentive, China does not meet the objective conditions for an overall bull market. The stock market will still mainly rely on structural investment opportunities.

10. By maintaining appropriate liquidity, there will be no more money squeezes.

We predict that interbank market liquidity will be relatively relaxed and remain at an appropriate level. Private sectors may feel liquidity squeeze, but the capital outflow caused by a Federal Reserve rate raise will not happen, which may lead to money shortages in real economy and interbank market.

Although the funds outstanding for foreign exchange will continue the trend of stopping being the main channel for putting China's monetary base into circulation, the possibilities of a shrink in the funds outstanding for foreign exchange is not high. So even if the Federal Reserve raises the rate, the global easing trend has not ended yet, and the Eurozone and Japan will maintain quantitative easy monetary policies. Even the Federal Reserve raises the rate, it will be tender and controllable. The too strong U.S. dollar will damage American enterprises' export competitive edges.

The shrink of the funds outstanding for foreign exchange will not necessarily lead to a money shortage. In June 2013, the major cause of the money shortage was the unchecked leveraged of the financial institutions that rely on shadow banking. In 2014, economic growth slowed and the scale of the shadow banking sector shrank. Though the funds outstanding for foreign exchange are low, the abundant interbank liquidity remains unchanged. Considering that the economic growth goal will probably be lowered in 2015, the real estate market will be weak, and the required reserve ratio will reach a record high. So even if the funds outstanding for foreign exchange shrink, there will no possibility of a money squeeze.

We should still pay attention to the credit crunch in private sector. The downturn in economic growth and the tone of monetary policies for total volume stabilization will cut back on the banks' risk appetite in private sector that may feel some funding pressure.